The FTSE 100’s largest company, Royal Dutch Shell (LSE: RDSB), has maintained its dividend throughout the oil market downturn. Today, the shares look temptingly priced for income investors, with a forecast P/E of 14 and a prospective yield of 6.6%.
Shell hasn’t cut its dividend payout since World War II. So the oil and gas giant’s board was always going to be reluctant to slash the payout. But the group’s size and ability to borrow money at very low interest rates have also played their part. There’s no doubt in my mind that since 2015, borrowed cash has been used to make up for a lack of earnings cover.
Noted fund manager Neil Woodford has criticised Shell’s decision to take this path. In March, Mr Woodford said he believes that both Shell and BP have “unsustainable dividends” that will only become affordable with a return to “sustainably higher oil prices”.
I’d normally agree with his stance. But in this case I’m willing to take a chance. I think Shell’s decision to sell assets and focus on fewer, larger projects with long-term potential makes sense. Its takeover of BG Group appears to have been successful in that Shell has acquired good quality assets it’s able to operate at a lower cost than BG.
Cash generation is now improving. According to chief executive Ben van Beurden, the group’s cash dividend payments have now been covered by free cash flow for the last nine months. Shell’s 2017 earnings are expected to provide dividend cover this year and this position should improve further in 2018.
The risk of a dividend cut hasn’t completely gone away. But I believe Shell’s 6.6% yield is safe enough to be attractive. I’d be happy to buy and hold at current levels.
This yield could hit 7%
Shares of Direct Line Insurance Group (LSE: DLG) have doubled in value since the well-known motor insurance firm floated in 2012. That’s not a bad rate of return, especially as this rise has been accompanied by some generous dividend payouts.
Like a number of insurance stocks, Direct Line aims to pay an ordinary dividend plus a special dividend. The board’s goal is for the ordinary dividend to be sustainable regardless of business performance. The special dividend is paid out of surplus cash each year, so it can vary widely. For example, the ordinary dividend rose from 13.8p to 14.6p per share last year. But the special one fell from 36.3p to 10p per share.
Analysts expect this year’s payout to total 23.1p per share, giving a forecast yield of 6.7%. They expect a return to dividend growth in 2018, with a forecast yield of 7.4%.
The attraction of Direct Line’s high yields should be that they are affordable. Insurance is a regulated business and insurers must meet certain standards before they can pay dividends, which are paid out of surplus cash.
The risk is that Direct Line’s special dividend is likely to rise in some years and fall in others. However, the group’s ordinary one is likely to be more reliable and gives a yield of 4.2%, which still seems attractive to me. I believe this cash generative stock could be a good income buy at current levels.